Most economic models of trade union behaviour focus on the determination of wages and employment. In the monopoly union model, the union maximizes its objective function which includes wages for a given labour demand curve; in the efficient bargain model, the firm and the union negotiate both wages and employment; while in the so-called `right-to-manage' model, the firm and the union negotiate over wages, but the firm decides the level of employment. Traditional versions of all these models typically neglect unions' possible effects on firms' decisions concerning other factors of production in particular the capital stock.

In Discussion Paper No. 506, Pasi Holm, Research Fellow Seppo Honkapohja and Erkki Koskela develop a two-period monopoly union model in which unions can affect the firm's choices of capital stock, and firms' investment behaviour may depend on how wages are determined. They estimate the model using annual data for Finnish manufacturing industry for 1960-87 in this first empirical study of trade union effects based on a model with endogenous capital stock, in which they also incorporate a variety of taxes.

In the first period, the union chooses the wage level and the firm chooses the capital stock. In the second, the firm decides on the level of employment for given levels of wages and the capital stock. Comparing equilibria, the authors find that higher unemployment benefit implies higher wages and employment and a lower capital stock, while an increased user cost of capital reduces both employment and the capital stock with no effect on wages. Moreover, under reasonable assumptions, increasing the income tax rate reduces both employment and the capital stock but increases wages.

The authors find that their system of equations to describe the determination of capital stock, wages and hours of work performs reasonably well, with no obvious signs of misspecification. They also use the results of various non-econometric tests to show that their model's hypothesis that hours of work are determined recursively after the wage-capital stock game fits the data better than the alternatives suggested by the conventional theory of demand for factors of production.

A Monopoly Union Model of Wage Determination with Taxes and Endogenous Capital Stock: An Empirical Application to the Finnish Manufacturing Industry
Pasi Holm, Seppo Honkapohja and Erkki Koskela

Discussion Paper No. 506, January 1991 (AM)